New York Markets After Hours

ECB’s Trichet signals hike, vows no default

Bank of England also leaves rates on hold

By

WilliamL. Watts

FRANKFURT (MarketWatch) — European Central Bank President Jean-Claude Trichet on Thursday signaled that interest rates will likely rise next month, while also reiterating the bank’s opposition to any restructuring of Greek debt that could be classified as a default.

In an opening statement at his monthly news conference, Trichet said upside inflation risks in the 17-nation euro zone warranted “strong vigilance,” a term often used to signal a rate hike at the next meeting of the central bank’s Governing Council. The central bank would act in a “firm and timely manner,” Trichet said.

Reuters

Jean-Claude Trichet, president of the European Central Bank.

Economists had widely expected Trichet to provide such a signal. Earlier, the ECB announced that the Governing Council opted to leave its refi rate unchanged at 1.25% at its June meeting, as expected.

Simon Smith, chief economist at FxPro, said fears the European Central Bank’s moving too aggressively amid concerns about the global recovery as well as the euro zone’s own sovereign-debt problems and a fragile banking sector may have limited the currency’s upside.

“It’s early days, but the weakening of the euro seen in the wake of Trichet’s press conference suggests tighter monetary policy could be shifting away from being unanimously euro-supportive,” Smith said, in emailed comments. “Trichet may be clear about what the ECB is doing, but there is less clarity that this is the right thing to do.”

Others tied the euro’s slip to Trichet’s remarks on inflation.

Updated ECB staff projections released Thursday said inflation in 2011 will come in between 2.5% to 2.7%, versus a March projection of 2% to 2.6%. the ECB narrowed its forecast for 2013 inflation to between 1.1% to 2.3% from a March projection of 1% to 2.4%.

The suggestion that inflation pressures could moderate in 2012 may have led many market participants to conclude a July move won’t mark the continuation of a series of rate hikes, said Boris Schlossberg, director of currency research at GFT.

The euro was also poised for a classic “sell the news” reaction given widespread expectations that Trichet would signal a July hike, he said.

The European Central Bank last hiked rates in April, lifting its refi rate by a quarter of a percentage point to 1.25%.

The news conference was nearly dominated, however, by questions over a clash pitting the central bank and France against Germany and other European Union countries over any restructuring of Greece’s debt as officials work out a second rescue package for the debt-wracked country.

Trichet reiterated the European Central Bank’s opposition to any form of involuntary restructuring that could be termed a “default” or “credit event” but also took pains to emphasize that it wasn’t doing battle with Germany or any other country on the issue.

“We exclude all concepts that would not be purely voluntary without coercion,” Trichet said, including any measures that could be declared a “selective default” by ratings agencies.

On Wednesday, Greek, Irish and Portuguese government bonds came under heavy pressure after German Finance Minister Wolfgang Schaeuble, in a letter to the European Central Bank and euro-zone finance ministers, reiterated a call for private bondholders to bear some of the pain of an additional Greek bailout and suggested a seven-year extension of Greek bond maturities.

Trichet emphasized that he wasn’t doing battle with any single nation’s finance minister, saying the central bank remains engaged in dialogue with the finance ministers from the euro zone and the European Union.

By leaving the door open to “purely voluntary” measures, however, Trichet indicated the European Central Bank’s previous opposition to a voluntary restructuring was starting to crumble, said Carsten Brzeski, euro-zone economist at ING Bank.

But by the same token, recent guidance from ratings companies means it will likely be very difficult for authorities to come up with a voluntary debt exchange that won’t be considered a default, he said.

Moody’s Investors Service on Thursday said it would be difficult to imagine structuring a voluntary program to restructure Greece’s debt.

“It’s hard to imagine something that’s truly voluntary in the current climate,” said Bart Oosterveld, managing director in charge of sovereign risk at Moody’s, during a Frankfurt news conference, Bloomberg reported.

Bank of England stays on hold

Earlier Thursday, the Bank of England, as expected, left its key lending rate unchanged at a record-low 0.5% as concerns over the strength of the economic recovery likely outweighed worries about above-target inflation.

Policy makers also left unchanged the central bank’s program of securities purchases at 200 billion British pounds ($328.2 billion).

The British pound
GBPUSD, -0.0074%
traded at $1.6372, a loss of 0.2% from Wednesday.

Ideas that the Bank of England would begin to tighten monetary policy as early as this spring have faded in the face of softer-than-expected data on the British and global economies, economists said.

“Although we believe a majority of [central bank voters] will move to tighten policy as soon as they are confident that aggregate demand is solid, the demand outlook is far from solid at present,” wrote economists at Barclays Capital.

Gross domestic product grew by 0.5% in the first quarter, merely canceling out a 0.5% decline seen in the final three months of 2010.

Meanwhile, a breakdown of the first-quarter data revealed a slump in consumer spending, which raises concerns about the economy’s ability to withstand fiscal austerity measures that started to kick in at the beginning of the government’s financial year in April, said Howard Archer, chief U.K. economist at IHS Global Insight.

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